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Ray Dalio Thinks The Bond Bull Market Could Finally Turn In 2013

Billionaire hedge fund guru Ray Dalio has made a living spotting undervalued assets to buy and overvalued ones to sell. Now, with a global deleveraging cycle forcing central bankers around the world to employ quantitative easing in one form or another, most assets are richly valued at a time when the capacity to ease monetary policy has been severely diminished.

To Dalio, all the pieces are in place for a great unraveling of the stunning bull run in bond markets like that for U.S. Treasury debt.

“The biggest opportunity will be – and it isn’t imminent – shorting bond markets around the world as [the] term structure of interest rates backs up,” Dalio said Wednesday at DealBook’s Opportunities For Tomorrow conference in New York.

The Bridgewater Associates founder tried to steer clear of a specific prediction on timing (those who live by the crystal ball are destined to eat ground glass, he quipped), but said “late next year [is] a point where rates could turn.”

Plenty of investors waiting on a stark reversal in rates have driven themselves mad. Even after the August 2011 debt ceiling debacle in Washington and subsequent downgrade from S&P that cut America’s AAA rating, the rate on 10-year Treasuries declined, rather than rising, and still stand at just 1.72%.

Whenever the flip does come, and Dalio has no doubt that it will eventually, it will “reverberate through all asset classes.” He thinks stocks will absorb the blow better than bonds that have been pushed to stunningly low yields.

Goldman Sachs’ Lloyd Blankfein issued a similar warning at the same conference Wednesday, while also noting that his firm is advising its corporate clients to take advantage of the low-rate environment to address their borrowing needs for years to come. (See “Blankfein: Curb Your Enthusiasm For 2013.”)

Another element to consider: the diminishing effect of the Federal Reserve’s stimulus efforts.

The first wave of quantitative easing was aimed at alleviating a liquidity crisis in the middle of financial turmoil, Dalio said. The second added more liquidity and had something of a wealth effect. Speaking on a day when Chairman Ben Bernanke and the FOMC said they will expand their balance sheet by another $45 billion in Treasury securities per month, Dalio said “we’re now at the point where the impact will be relatively little.”

Josh Brown points out at his Reformed Broker blog that the subdued reaction to the latest Fed announcement is hardly reason to call central bank policy utterly ineffective. He is right about the short-term nature of such a statement, but there is evidence that the marginal utility, or the magnitude of stock-market gains following Fed action is lessening.

Fund manager Jeffrey Gundlach has zeroed in on the diminishing returns of Fed stimulus, arguing in a conference call last week that the central bank is “at the point where the payoff appears to be nonexsistent.”

Gundlach noted that the impact of subsequent easing after the first batch has essentially been cut in half each time, from a 50% jump in the S&P 500 on the back of QE1 to just an 8% gain from the most recent strategy of QE3 plus Operation Twist. (Business Insider has the chart from Gundlach’s presentation here.)

The U.S. has never experienced an economic downturn – likely even with a fiscal cliff deal – at the same time the central bank did not have the ability to ease monetary policy, Dalio said. That creates a risk, and while it may not be probable that risk gets out of control, it is possible, he added.

Fuss doesn’t play the timing game, but he bailed on long-term Treasury securities a while ago. “Sometimes we say thank God we don’t have them, other times…”

Instead of long-term Treasuries, Fuss wants to buy bonds that are not tightly tied to the interest rates paid by the U.S. government. Loomis Sayles is hardly the only asset manager chasing those investments though, which means the opportunities are smaller than normal.

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